Question

In: Economics

Suppose that the first national bank currently holds a total of 45 million dollars in deposits...

Suppose that the first national bank currently holds a total of 45 million dollars in deposits from over 120,000 clients. At the same time, the total amount of loans people owe the bank is 18 million dollars, and the bank cannot legally issue more loans without attracting additional deposits. Assume that the bank currently has 3 million dollars in cash and 2 million dollars worth of securities invested in the financial market. The bank also owns some physical assets, such as its office building.

Suppose now someone saves another $52 into his checking account at the first national bank, what is the maximum amount of deposits that can be generated (including this initial deposit) by the fractional reserve banking system?

Round your answer to 2 digits after the decimal point.

Expert Solution

The bank currently has $3 million in cash.

It has been stated that bank cannot legally issue more loans without attracting additional deposits.

This means that bank do not have any excess reserves and has only required reserves.

cash holding by bank amounts to its required reserves.

So,

Required reserves = $3 million

Total deposits = $45 million

Calculate the required reserves ratio -

Required reserve ratio = (Required reserves/Total deposits) = ($3 million/$45 million) = 6.67

The required reserve ratio is 6.67%.

New deposits = $52

Required reserve ratio = 6.67% or 0.0667

Calculate the money multiplier -

Money multiplier = 1/required reserve ratio = 1/0.0667 = 14.99 or 15 (rounding off)

The money multiplier is 15.

Calculate the maximum amount of deposits that can be generated -

Maximum amount = New deposit * Money Multiplier = $52 * 15 = $780

Thus,

The maximum amount of deposits that can be generated is $780.

Rahul Sunny answered 1 hour ago

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